WASHINGTON — Some broker-dealers and some issuers have distorted the truth about the municipal advisor rule, said a former Securities and Exchange Commission lawyer who worked on the new regulatory regime.
Dave Sanchez, who worked in the SEC's muni office from 2010 through 2013 and who has spent the last year general counsel to investment banking firm De La Rosa & Co. discussed the industry's reaction to the rule with the Bond Buyer shortly before its final effective date July 1. SEC muni chief John Cross has publicly acknowledged Sanchez's extensive involvement in developing the rule, which was unanimously approved by the commission and released in fall 2013 to great anticipation. Reaction from dealers and some other market participants quickly turned negative, a response Sanchez said is "disappointing."
Under the MA regime, persons or firms that give advice to state or local governments about issuing muni bonds or the investment of muni proceeds or escrows must register with regulators and are subject to a fiduciary duty to put municipal clients' interests ahead of their own.
"The reaction has been disappointing because a lot of market participants are simply reacting with negativity, but seemingly without any real attempt to view the rule from any vantage point other than their own narrow interests," Sanchez said. Some market participants he spoke to had worked themselves into a tizzy over things not actually in the rule at all, he said.
While he acknowledged that some of the negative reaction to a long, complex rule is natural and understandable, Sanchez didn't shy from criticizing the approach of some dealer representatives because he didn't think their arguments were helpful . One of his biggest complaints is the dealer claim that federal lawmakers intended only to reign in the unregulated non-dealer municipal advisors when they included the muni advisor registration requirement in the Dodd Frank Act. Both individual firms and dealer groups have made that claim repeatedly in recent years, and Securities Industry and Financial Markets Association president and chief executive officer Kenneth Bentsen deployed it again in a speech to issuer officials in May.
"I find it surprising that some parties continue to claim that the 'congressional intent' of the MA rule was only to regulate entities that were previously unregulated financial advisors," Sanchez said. "That is just not a credible position. I think it is obvious that when you look at what Congress did, that perspective does not hold up."
Dealer groups have underscored that their member firms who offer MA services have for years been subject to regulation that protects customers, including the Municipal Securities Rulemaking Board's Rule G-17 on fair dealing.
Congress never endorsed the idea of status-based exemptions, Sanchez asserted, and said the very idea "would invite the worst kind of regulatory arbitrage" and "provide an unfair competitive advantage to firms providing advice to municipal entities that just happened to be regulated for other purposes."
"They would be allowed to do the same work as municipal advisors but be subject to a lesser duty," Sanchez said. "To turn that argument on its head: should the SEC now allow financial advisors to act as broker-dealers without having to comply with any broker-dealer specific regulations such as net capital requirements or 15c2-12? Would that be fair since these financial advisors are now 'otherwise regulated' as municipal advisors? Of course it would not be fair."
Some larger issuers have joined dealers in blasting the SEC's regulatory approach. High-ranking officials from large issuers such as Virginia treasurer Manju Ganeriwala and Florida bond finance director Ben Watkins have both expressed apprehension that the MA rule will prevent them from freely receiving useful ideas from investment bankers. The SEC provided exclusions and exemptions in the rule designed to allow a free dialog under some circumstances, but the ease with which those could be used has been challenged by some market participants.
Sanchez said the SEC needs to be doing more to get its message out, because many issuers are continuing to get the bulk of their information about how the SEC's MA rule and subsequent MSRB rules will affect them from dealers.
"Some individual dealer communications about the MA Rule are so distorted, I think that they could be G-17 violations in and of themselves," Sanchez said.
But regulators have to be honest about the fact that a lot of the nervousness in the market and the seeming attempt to "skirt the law" with cleverly-drafted documents exists because participants do not trust regulators to evaluate substance. This can lead to an environment where form takes precedence over the intent of the rules, Sanchez warned. Ultimately, it will be up to the enforcers to set good priorities and the MSRB to set up a coherent framework to make the new regime run smoothly. The SEC and the Financial Industry Regulatory Authority will have to get MAs "thinking seriously" about their duties under the rule and "defend the borders" against incursions by broker-dealers, attorneys, engineers and banks who might be acting as unregistered MAs, he added.
"There is definitely a new regulatory normal for the municipal market and market reactions to things like the {SEC's} Municipalities Continuing Disclosure Cooperation Initiative and the MA rule show that a lot of market participants are really struggling with this reality," Sanchez said. "But, as in any environment, the most successful people are going to be the ones that adapt and in order to do that you have to understand the new environment and not just rail against the fact that there has been a change."
